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New York District Court Permits Recoupment of Defense Costs

Blogs, Insurance Coverage

Applying New York law, the United States District Court for the Southern District of New York held that a D&O insurer which reserved its right to recoup uncovered defense costs could do so even if it failed to affirmatively seek recoupment of such costs in a prior coverage action. Women’s Integrated Network, Inc. v. U.S. Specialty Ins. Co., Case No. 7:12-cv-07072-VB, 2014 WL 894501 (S.D.N.Y. Mar. 7, 2014).

The insurer, U.S. Specialty Ins. Co. (“USSIC”), insured Women’s Integrated Network, Inc. (“WIN”) under a Directors, Officers, and Organization Liability Insurance Policy, which provided, in relevant part, that USSIC would “pay covered Defense Costs on an as-incurred basis” if WIN was sued, but also that, “[i]f it is finally determined that any Defense Costs paid by the Insurer are not covered under this Policy, the Insuredsagree to repay such non-covered Defense Costs to the Insurer.” When WIN was sued by a former employee for wrongful termination, USSIC initially denied coverage but eventually agreed to pay a portion of WIN’s defense costs subject to a reservation of rights. In its reservation of rights letter, USSIC wrote that it reserved the right “to take the position at a later date that coverage is not available for any aspect of [the relevant] Complaints, including but not limited to fees and costs incurred in the defense.” 

In a coverage action commenced by WIN, the Court granted USSIC’s motion for judgment on the pleadings, holding that there was no coverage under the Policy either for defense costs or for the settlement of the underlying claim against WIN. USSIC subsequently demanded repayment of the defense costs it had paid in defense of the underlying wrongful termination litigation. WIN refused and, instead, filed an action seeking a declaration that USSIC was not entitled to recoup its costs. USSIC filed a counterclaim based on WIN’s failure to repay the uncovered defense costs on demand.

In addressing USSIC’s motion for summary judgment, the Court rejected WIN’s argument that res judicata precluded USSIC from bringing its recoupment counterclaim because it could have, but failed to, bring that claim in the prior coverage action. More specifically, the Court noted that “[o]nly compulsory, and not permissive, counterclaims are subject to res judicata,” and USSIC’s counterclaim was not compulsory because it was “ripe” until it was “finally determined” that there was no coverage. Moreover, the Court found that the “actionable conduct” giving rise to USSIC’s counterclaim – i.e., WIN’s decision to bring a declaratory judgment action rather than repaying the defense costs upon USSIC’s demand – occurred after the filing of the underlying coverage action and, thus, res judicata did not apply. As a result, the Court granted summary judgment in favor of the insurer.